Central Bank Watch: BOC & ECB Interest Rate Expectations Update
Central Bank Watch Overview:
- Both the Bank of Canada and European Central Bank met in recent days, setting the tone for 2021: more easing is possible, but might not be needed.
- While the BOC outright complained about Canadian Dollar strength, there’s also the consideration that they can’t do much to stop further appreciation. On the other hand, the ECB avoided specific reference to the Euro itself.
- Retail trader positioning indicates that suggests that EUR/USD rates may climb while USD/CAD rates may fall.
Central Banks Coming into Focus
In this edition of Central Bank Watch, we’ll cover two the first two major central banks to hold rate decisions in 2021: the Bank of Canada and the European Central Bank. The two central banks are quite different, insofar as the ECB’s firepower is on par with the Federal Reserve’s, while the BOC’s lags far behind. Furthermore, the Euro is considered among the global reserve currencies while the Canadian Dollar is not. But both central banks face the same problem: a weaker US Dollar in recent months that has provoked appreciation in their currencies, which threatens to dampen exports and cause drag in the recovery from the coronavirus pandemic.
For more information on central banks, please visit the DailyFX Central Bank Release Calendar.
Bank of Canada Warns on CAD Strength
While the Bank of Canada stood pat at its first meeting of the year, Governor Tiff Macklem did not mince words over the problem that an appreciating Loonie is posing for the Canadian economy. “In this situation where we’ve seen this broad-based US dollar deprecation that doesn’t reflect some positive development in Canada that the exchange rate is absorbing…the exchange rate is starting to create a material headwind for the Canadian economy.” Furthermore, it was noted that the recent Canadian Dollar appreciation “is weighing on our exports and its also making it harder for our domestic producers to compete against firms in other countries.”
Unfortunately for the BOC, there’s not much that can be done to prevent the Canadian Dollar appreciation vis-à-vis USD/CAD, at least, as Governor Macklem concedes, when “in a situation where our Canada-U.S. exchange rate is moving largely because of made-in-U.S. developments as opposed to made-in-Canada developments.”
Bank of Canada Interest Rate Expectations (JANUARY 21, 2021) (Table 1)
Accordingly, traders are largely seeing the Bank of Canada as posturing about their ability to keep the Canadian Dollar weaker, particularly as global growth accelerates and vaccine distribution spreads. Through December 2021, there is only a 32% chance of a 25-bps rate hike by the BOC, up meaningfully from the 7% cut odds in place at the start of the year. Markets are betting that Canadian Dollar strength will continue.
IG Client Sentiment Index: USD/CAD Rate Forecast (JANUARY 21, 2021) (Chart 1)
USD/CAD: Retail trader data shows 74.03% of traders are net-long with the ratio of traders long to short at 2.85 to 1. The number of traders net-long is 23.98% higher than yesterday and 17.82% higher from last week, while the number of traders net-short is 19.58% lower than yesterday and 8.33% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/CAD-bearish contrarian trading bias.
ECB Ignores Gorilla in the Room
Not once during her press conference did European Central Bank President Christine Lagarde mention the Euro exchange rate directly, a hawkish subtext to an otherwise hawkish tone established in the first policy meeting of 2021. The ECB acknowledged that "if favorable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full.” In other words, it may not need to provide as much stimulus as previously anticipated.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (January 21, 2021) (TABLE 2)
According to Eurozone overnight index swaps, there has been a sharp shift in interest rate cut expectations in recent week. At the end of 2020, rates markets were pricing in a 10-bps rate cut in July 2021. Now, if a rate cut comes this year, it will come in December 2021 (54% chance). A further rise in European bond yields, now that the ECB is saying it may not do further stimulus (if only for the market to ‘test’ the ECB’s commitment), could provoke a further retracement in rate cut expectations, helping buoy the Euro.
IG Client Sentiment Index: EUR/USD Rate Forecast (January 21, 2021) (Chart 2)
EUR/USD: Retail trader data shows 43.86% of traders are net-long with the ratio of traders short to long at 1.28 to 1. The number of traders net-long is 4.13% lower than yesterday and 2.46% lower from last week, while the number of traders net-short is 4.59% higher than yesterday and 1.34% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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